The Reserve Bank of India (RBI) on Monday reduced the requirements for coverage for external commercial loans (ECB) from 3-5 years to 70 percent from 100 percent.
At the time of the renewal of existing coverage, the mandatory limit would automatically be reduced to 70 percent, RBI said in a notice on its website.
The reduction in coverage would help Indian companies borrow funds relatively cheaply, since the cost of coverage added substantially to the final cost.
For example, the cost of coverage for one-year loans would be around 5 percent, which increases the interest rate. If 70 percent of the loan is covered, a substantial part of the requirement is saved.
"The RBI is listening to the government, which wanted to lower the cost of funds for companies. Undoubtedly, this measure will help reduce the cost of foreign sources for companies in India, "said the CFO of a large company that requests not to be cited.
This will particularly help companies with a substantial part of natural coverage, or those that earn in foreign currency.
The requirement of external coverage could be almost zero or approximately for some of these firms, said an executive of the rating agency.
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In addition, the demand for term dollars is also reduced to some extent and can help strengthen the rupee in that segment. The coverage is essentially to contract dollars to term.
The RBI wanted the companies to be fully covered, since uncovered dollar exposures were a risk for bank loans to these companies. The RBI had also told banks to make loans expensive for companies that are not fully covered.
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Therefore, reducing the coverage requirement may seem surprising, but it is not unusual.
Globally, the coverage requirement is around 50 percent for most emerging market countries that are exposed to fluctuations in the global currency.